A stock analyst is responsible for studying the performance of a company and predict future trends. The forecasts could either be fundamental analysis or quantitative analysis. These insights might indicate favorable positions when a security undergoes a price correction. They also issue buy or sell recommendations, expected quarterly performance, projected price targets, etc.
Analyst recommendations are typically labeled buy sell or hold. Investors look for these recommendations before taking positions. These suggestions are also taken after the issuance of a financial report or a press announcement by a certain company. The change in opinion of analysts to buy, sell or hold a stock leads to a stock upgrade or downgrade. A MotleyFool publication, analysts rate stocks using a three-tier system:
- A buy recommendation suggests a positive outlook of the analyst. In such cases, the analyst feels that a stock will outperform the market or its peers. This recommendation can affect the stock’s price and lead to an upgrade.
- A sell recommendation indicates a bearish view of a stock. Here, an analyst expects the stock to underperform vis-a-vis its peers. Though a sell rating is rare, it can ultimately lead to a downgrade.
- A ‘hold’ recommendation hints that it is not going to perform better or worse than the market as a whole. While a hold rating isn’t a recommendation to buy the stock, it also isn’t a recommendation to sell.
What is a Stock Upgrade?
Investopedia defines an upgrade as a positive change in an analyst’s outlook of a particular security’s valuation. This view is based primarily on the improving fundamentals of this security.
Traders and clients of the analyst rush at this buy signal. This increases the demand for the stocks and in turn and boosts its price. Investors who hold such stocks during this period can benefit from a short-term gain. They can sell the security at a higher or upgrade price, exiting the market with a profit. For investors who don’t own a stake in the company, investing at an upgraded price can be expensive.
Long-term investors with optimistic long-term views about the company’s performance can hold the security as long as they wish to.
Upgrades can occur as a reaction to something big that happened in the company. For example, a strong financial or earnings report, a big merger, etc.
What is a Downgrade?
As the name suggests, a downgrade is an inverse of an analyst upgrade. When an analyst changes its rating from hold to sell or buy to hold, it represents a bearish view. This can lead others to sell the security, resulting in a decrease in the company’s stock price.
Any negative news about a company could drive down its analyst rating to sell. Deteriorating fundamentals or the existing market dynamics may also trigger a sell recommendation. Other factors may include headwinds from the macro environment affecting the company’s line of business.
A belief that a stock’s price rise is disproportional to its underlying company’s profits can raise alarms. The analyst may downgrade the stock despite no change in the company’s long-term prospects.
Similar to upgrades, downgrade can occur as a reaction to some news. For example, a company doesn’t report the expected performance in a specific financial quarter.